WHERE THE BANKER IS SUPERFLUOUS
The abolition of interlocking directorates will greatly curtail the
bankers’ power by putting an end to many improper combinations.
Publicity concerning bankers’ commissions, profits and associates, will
lend effective aid, particularly by curbing undue exactions. Many of
the specific measures recommended by the Pujo Committee (some of them
dealing with technical details) will go far toward correcting corporate
and banking abuses; and thus tend to arrest financial concentration.
But the investment banker has, within his legitimate province, acquired
control so extensive as to menace the public welfare, even where his
business is properly conducted. If the New Freedom is to be attained,
every proper means of lessening that power must be availed of. A simple
and effective remedy, which can be widely applied, even without new
legislation, lies near at hand:--Eliminate the banker-middleman where
he is superfluous.
Today practically all governments, states and municipalities pay toll
to the banker on all bonds sold. Why should they? It is not because the
banker is always needed. It is because the banker controls the only
avenue through which the investor in bonds and stocks can ordinarily be
reached. The banker has become the universal tax gatherer. True, the
_pro rata_ of taxes levied by him upon our state and city governments
is less than that levied by him upon the corporations. But few states
or cities escape payment of some such tax to the banker on every
loan it makes. Even where the new issues of bonds are sold at public
auction, or to the highest bidder on sealed proposals, the bankers’
syndicates usually secure large blocks of the bonds which are sold
to the people at a considerable profit. The middleman, even though
unnecessary, collects his tribute.
There is a legitimate field for dealers in state and municipal bonds,
as for other merchants. Investors already owning such bonds must have a
medium through which they can sell their holdings. And those states or
municipalities which lack an established reputation among investors, or
which must seek more distant markets, need the banker to distribute new
issues. But there are many states and cities which have an established
reputation and have a home market at hand. These should sell their
bonds direct to investors without the intervention of a middleman.
And as like conditions prevail with some corporations, their bonds
and stocks should also be sold direct to the investor. Both financial
efficiency and industrial liberty demand that the bankers’ toll be
abolished, where that is possible.
BANKER AND BROKER
The business of the investment banker must not be confused with
that of the bond and stock broker. The two are often combined; but
the functions are essentially different. The broker performs a very
limited service. He has properly nothing to do with the original
issue of securities, nor with their introduction into the market.
He merely negotiates a purchase or sale as agent for another under
specific orders. He exercises no discretion, except in the method of
bringing buyer and seller together, or of executing orders. For his
humble service he receives a moderate compensation, a commission,
usually one-eighth of one per cent. (12 1/2 cents for each $100) on
the par value of the security sold. The investment banker also is
a mere middleman. But he is a principal, not an agent. He is also
a merchant in bonds and stocks. The compensation received for his
part in the transaction is in many cases more accurately described
as profit than as commission. So far as concerns new issues of
government, state and municipal bonds, especially, he acts as merchant,
buying and selling securities on his own behalf; buying commonly at
wholesale from the maker and selling at retail to the investors;
taking the merchant’s risk and the merchant’s profits. On purchases
of corporate securities the profits are often very large; but even a
large profit may be entirely proper; for when the banker’s services
are needed and are properly performed, they are of great value. On
purchases of government, state and municipal securities the profit is
usually smaller; but even a very small profit cannot be justified, if
unnecessary.
HOW THE BANKER CAN SERVE
The banker’s services include three distinct functions, and only three:
_First:_ Specifically as expert. The investment banker has the
responsibility of the ordinary retailer to sell only that merchandise
which is good of its kind. But his responsibility in this respect is
unusually heavy, because he deals in an article on which a great
majority of his customers are unable, themselves, to pass intelligent
judgment without aid. The purchase by the investor of most corporate
securities is little better than a gamble, where he fails to get the
advice of some one who has investigated the security thoroughly as the
banker should. For few investors have the time, the facilities, or the
ability to investigate properly the value of corporate securities.
_Second:_ Specifically as distributor. The banker performs an
all-important service in providing an outlet for securities.
His connections enable him to reach possible buyers quickly.
And good-will--that is, possession of the confidence of regular
customers--enables him to effect sales where the maker of the security
might utterly fail to find a market.
_Third:_ Specifically as jobber or retailer. The investment banker,
like other merchants, carries his stock in trade until it can be
marketed. In this he performs a service which is often of great value
to the maker. Needed cash is obtained immediately, because the whole
issue of securities can thus be disposed of by a single transaction.
And even where there is not immediate payment, the knowledge that the
money will be provided when needed is often of paramount importance.
By carrying securities in stock, the banker performs a service also to
investors, who are thereby enabled to buy securities at such times as
they desire.
Whenever makers of securities or investors require all or any of
these three services, the investment banker is needed, and payment of
compensation to him is proper. Where there is no such need, the banker
is clearly superfluous. And in respect to the original issue of many
of our state and municipal bonds, and of some corporate securities, no
such need exists.
WHERE THE BANKER SERVES NOT
It needs no banker experts in value to tell us that bonds of
Massachusetts or New York, of Boston, Philadelphia or Baltimore and
of scores of lesser American cities, are safe investments. The basic
financial facts in regard to such bonds are a part of the common
knowledge of many American investors; and, certainly, of most possible
investors who reside in the particular state or city whose bonds are
in question. Where the financial facts are not generally known, they
are so simple, that they can be easily summarized and understood by
any prospective investor without interpretation by an expert. Bankers
often employ, before purchasing securities, their own accountants
to verify the statements supplied by the makers of the security, and
use these accountants’ certificates as an aid in selling. States and
municipalities, the makers of the securities, might for the same
purpose employ independent public accountants of high reputation, who
would give their certificates for use in marketing the securities.
Investors could also be assured without banker-aid that the basic
legal conditions are sound. Bankers, before purchasing an issue of
securities, customarily obtain from their own counsel an opinion as to
its legality, which investors are invited to examine. It would answer
the same purpose, if states and municipalities should supplement the
opinion of their legal representatives by that of independent counsel
of recognized professional standing, who would certify to the legality
of the issue.
Neither should an investment banker be needed to find investors
willing to take up, in small lots, a new issue of bonds of New York or
Massachusetts, of Boston, Philadelphia or Baltimore, or a hundred other
American cities. A state or municipality seeking to market direct to
the investor its own bonds would naturally experience, at the outset,
some difficulty in marketing a large issue. And in a newer community,
where there is little accumulation of unemployed capital, it might be
impossible to find buyers for any large issue. Investors are apt to be
conservative; and they have been trained to regard the intervention of
the banker as necessary. The bankers would naturally discourage any
attempt of states and cities to dispense with their services. Entrance
upon a market, hitherto monopolized by them, would usually have to be
struggled for. But banker-fed investors, as well as others could, in
time, be brought to realize the advantage of avoiding the middleman and
dealing directly with responsible borrowers. Governments, like private
concerns, would have to do educational work; but this publicity would
be much less expensive and much more productive than that undertaken by
the bankers. Many investors are already impatient of banker exactions;
and eager to deal directly with governmental agencies in whom they
have more confidence. And a great demand could, at once, be developed
among smaller investors whom the bankers have been unable to interest,
and who now never buy state or municipal bonds. The opening of this
new field would furnish a market, in some respects more desirable and
certainly wider than that now reached by the bankers.
Neither do states or cities ordinarily need the services of the
investment banker to carry their bonds pending distribution to the
investor. Where there is immediate need for large funds, states and
cities--at least the older communities--should be able to raise the
money temporarily, quite as well as the bankers do now, while awaiting
distribution of their bonds to the investor. Bankers carry the bonds
with other people’s money, not with their own. Why should not cities
get the temporary use of other people’s money as well? Bankers have
the preferential use of the deposits in the banks, often because
they control the banks. Free these institutions from banker-control,
and no applicant to borrow the people’s money will be received with
greater favor than our large cities. Boston, with its $1,500,000,000
of assessed valuation and $78,033,128 net debt, is certainly as good a
risk as even Lee, Higginson & Co. or Kidder, Peabody & Co.
But ordinarily cities do not, or should not, require large sums of
money at any one time. Such need of large sums does not arise except
from time to time where maturing loans are to be met, or when some
existing public utility plant is to be taken over from private owners.
Large issues of bonds for any other purpose are usually made in
anticipation of future needs, rather than to meet present necessities.
Modern efficient public financiering, through substituting serial
bonds for the long term issues (which in Massachusetts has been made
obligatory) will, in time, remove the need of large sums at one time
for paying maturing debts, since each year’s maturities will be paid
from the year’s taxes. Purchases of existing public utility plants
are of rare occurrence, and are apt to be preceded by long periods
of negotiation. When they occur they can, if foresight be exercised,
usually be financed without full cash payment at one time.
Today, when a large issue of bonds is made, the banker, while
ostensibly paying his own money to the city, actually pays to the city
other people’s money which he has borrowed from the banks. Then the
banks get back, through the city’s deposits, a large part of the money
so received. And when the money is returned to the bank, the banker has
the opportunity of borrowing it again for other operations. The process
results in double loss to the city. The city loses by not getting from
the banks as much for its bonds as investors would pay. And then it
loses interest on the money raised before it is needed. For the bankers
receive from the city bonds bearing rarely less than 4 per cent.
interest; while the proceeds are deposited in the banks which rarely
allow more than 2 per cent. interest on the daily balances.
CITIES THAT HELPED THEMSELVES
In the present year some cities have been led by necessity to help
themselves. The bond market was poor. Business was uncertain, money
tight and the ordinary investor reluctant. Bankers were loth to take
new bond issues. Municipalities were unwilling to pay the high rates
demanded of them. And many cities were prohibited by law or ordinance
from paying more than 4 per cent. interest; while good municipal bonds
were then selling on a 4 1/2 to 5 per cent. basis. But money had to be
raised, and the attempt was made to borrow it direct from the lenders
instead of from the banker-middleman. Among the cities which raised
money in this way were Philadelphia, Baltimore, St. Paul, and Utica,
New York.
Philadelphia, under Mayor Blankenburg’s inspiration, sold nearly
$4,175,000 in about two days on a 4 per cent. basis and another
“over-the-counter” sale has been made since. In Baltimore, with the
assistance of the _Sun_, $4,766,000 were sold “over the counter” on a
4 1/2 per cent. basis. Utica’s two “popular sales” of 4 1/2 per cent.
bonds were largely “over-subscribed.” And since then other cities large
and small have had their “over-the-counter” bond sales. The experience
of Utica, as stated by its Controller, Fred G. Reusswig, must prove of
general interest:
“In June of the present year I advertised for sale two issues, one of
$100,000, and the other of $19,000, bearing interest at 4 1/2 per cent.
The latter issue was purchased at par by a local bidder and of the
former we purchased $10,000 for our sinking funds. That left $90,000
unsold, for which there were no bidders, which was the first time that
I had been unable to sell our bonds. About this time the ‘popular
sales’ of Baltimore and Philadelphia attracted my attention. The laws
in effect in those cities did not restrict the officials as does our
law and I could not copy their methods. I realized that there was
plenty of money in this immediate vicinity and if I could devise a plan
conforming with our laws under which I could make the sale attractive
to small investors it would undoubtedly prove successful. I had found,
in previous efforts to interest people of small means, that they did
not understand the meaning of premium and would rather not buy than
bid above par. They also objected to making a deposit with their bids.
In arranging for the ‘popular sales’ I announced in the papers that,
while I must award to the highest bidder, it was my opinion that a par
bid would be _the highest bid_. I also announced that we would issue
bonds in denominations as low as $100 and that we would not require a
deposit except where the bid was $5,000 or over. Then I succeeded in
getting the local papers to print editorials and local notices upon
the subject of municipal bonds, with particular reference to those
of Utica and the forthcoming sale. All the prospective purchaser had
to do was to fill in the amount desired, sign his name, seal the bid
and await the day for the award. I did not have many bidders for very
small amounts. There was only one for $100 at the first sale and one
for $100 at the second sale and not more than ten who wanted less than
$500. Most of the bidders were looking for from $1,000 to $5,000, but
nearly all were people of comparatively small means, and with some
the investment represented all their savings. In awarding the bonds
I gave preference to residents of Utica and I had no difficulty in
apportioning the various maturities in a satisfactory way.
“I believe that there are a large number of persons in every city who
would buy their own bonds if the way were made easier by law. Syracuse
and the neighboring village of Ilion, both of which had been unable
to sell in the usual way, came to me for a program of procedure and
both have since had successful sales along similar lines. We have been
able by this means to keep the interest rate on our bonds at 4 1/2 per
cent., while cities which have followed the old plan of relying upon
bond houses have had to increase the rate to 5 per cent. I am in favor
of amending the law in such a manner that the Common Council, approved
by the Board of Estimate and Apportionment, may fix the prices at which
bonds shall be sold, instead of calling for competitive bids. Then
place the bonds on sale at the Controller’s office to any one who will
pay the price. The prices upon each issue should be graded according to
the different values of different maturities. Under the present law, as
we have it, conditions are too complicated to make a sale practicable
except upon a basis of par bids.”
THE ST. PAUL EXPERIMENT
St. Paul wisely introduced into its experiment a more democratic
feature, which Tom L. Johnson, Cleveland’s great mayor, thought
out (but did not utilize), and which his friend W. B. Colver, now
Editor-in-Chief of the _Daily News_, brought to the attention of the
St. Paul officials. Mayor Johnson had recognized the importance of
reaching the small savings of the people; and concluded that it was
necessary not only to issue the bonds in very small denominations, but
also to make them redeemable at par. He sought to combine practically,
bond investment with the savings bank privilege. The fact that
municipal bonds are issuable ordinarily only in large denominations,
say, $1,000, presented an obstacle to be overcome. Mayor Johnson’s plan
was to have the sinking fund commissioners take large blocks of the
bonds, issue against them certificates in denominations of $10, and
have the commissioners agree (under their power to purchase securities)
to buy the certificates back at par and interest. Savings bank
experience, he insisted, showed that the redemption feature would not
prove an embarrassment; as the percentage of those wishing to withdraw
their money is small; and deposits are nearly always far in excess of
withdrawals.
The St. Paul sinking fund commissioners and City Attorney O’Neill
approved the Johnson plan; and in the face of high money rates, sold
on a 4 per cent. basis, during July, certificates to the net amount of
$502,300; during August, $147,000; and during September, over $150,000,
the average net sales being about $5,700 a day. Mr. Colver, reporting
on the St. Paul experience, said:
“There have been about 2,000 individual purchasers making the
average deposit about $350 or $360. There have been no certificates
sold to banks. During the first month the deposits averaged
considerably higher and for this reason: in very many cases people
who had savings which represented the accumulation of considerable
time, withdrew their money from the postal savings banks, from the
regular banks, from various hiding places and deposited them with
the city. Now these same people are coming once or twice a month
and making deposits of ten or twenty dollars, so that the average
of the individual deposit has fallen very rapidly during September
and every indication is that the number of small deposits will
continue to increase and the relatively large deposits become less
frequent as time goes on.
“As a matter of fact, these certificate deposits are stable, far
more than the deposits and investments of richer people who watch
for advantageous reinvestments and who shift their money about
rather freely. The man with three or four hundred dollars savings
will suffer almost anything before he will disturb that fund. We
believe that the deposits every day here, day in and day out, will
continue to take care of all the withdrawals and still leave a net
gain for the day, that net figure at present being about $5,700 a
day.”
Many cities are now prevented from selling bonds direct to the small
investors, through laws which compel bonds to be issued in large
denominations or which require the issue to be offered to the highest
bidder. These legislative limitations should be promptly removed.
SALESMANSHIP AND EDUCATION
Such success as has already been attained is largely due to the unpaid
educational work of leading progressive newspapers. But the educational
work to be done must not be confined to teaching “the people”--the
buyers of the bonds. Municipal officials and legislators have quite as
much to learn. They must, first of all, study salesmanship. Selling
bonds to the people is a new art, still undeveloped. The general
problems have not yet been worked out. And besides these problems
common to all states and cities, there will be, in nearly every
community, local problems which must be solved, and local difficulties
which must be overcome. The proper solution even of the general
problems must take considerable time. There will have to be many
experiments made; and doubtless there will be many failures. Every
great distributor of merchandise knows the obstacles which he had to
overcome before success was attained; and the large sums that had to be
invested in opening and preparing a market. Individual concerns have
spent millions in wise publicity; and have ultimately reaped immense
profits when the market was won. Cities must take their lessons from
these great distributors. Cities must be ready to study the problems
and to spend prudently for proper publicity work. It might, in the end,
prove an economy, even to allow, on particular issues, where necessary,
a somewhat higher interest rate than bankers would exact, if thereby
a direct market for bonds could be secured. Future operations would
yield large economies. And the obtaining of a direct market for city
bonds is growing ever more important, because of the huge increase in
loans which must attend the constant expansion of municipal functions.
In 1898 the new municipal issues aggregated $103,084,793; in 1912,
$380,810,287.
SAVINGS BANKS AS CUSTOMERS
In New York, Massachusetts and the other sixteen states where a
system of purely mutual savings banks is general, it is possible,
with a little organization, to develop an important market for the
direct purchaser of bonds. The bonds issued by Massachusetts cities
and towns have averaged recently about $15,000,000 a year, and those
of the state about $3,000,000. The 194 Massachusetts savings banks,
with aggregate assets of $902,105,755.94, held on October 31, 1912,
$90,536,581.32 in bonds and notes of states and municipalities. Of this
sum about $60,000,000 are invested in bonds and notes of Massachusetts
cities and towns, and about $8,000,000 in state issues. The deposits
in the savings banks are increasing at the rate of over $30,000,000
a year. Massachusetts state and municipal bonds have, within a few
years, come to be issued tax exempt in the hands of the holder,
whereas other classes of bonds usually held by savings banks are
subject to a tax of one-half of one per cent. of the market value.
Massachusetts savings banks, therefore, will to an increasing extent,
select Massachusetts municipal issues for high-grade bond investments.
Certainly Massachusetts cities and towns might, with the coöperation of
the Commonwealth, easily develop a “home market” for “over-the-counter”
bond business with the savings banks. And the savings banks of other
states offer similar opportunities to their municipalities.
COÖPERATION
Bankers obtained their power through combination. Why should not cities
and states by means of coöperation free themselves from the bankers?
For by coöperation between the cities and the state, the direct
marketing of municipal bonds could be greatly facilitated.
Massachusetts has 33 cities, each with a population of over 12,000
persons; 71 towns each with a population of over 5,000; and 250 towns
each with a population of less than 5,000. Three hundred and eight of
these municipalities now have funded indebtedness outstanding. The
aggregate net indebtedness is about $180,000,000. Every year about
$15,000,000 of bonds and notes are issued by the Massachusetts cities
and towns for the purpose of meeting new requirements and refunding
old indebtedness. If these municipalities would coöperate in marketing
securities, the market for the bonds of each municipality would be
widened; and there would exist also a common market for Massachusetts
municipal securities which would be usually well supplied, would
receive proper publicity and would attract investors. Successful
merchandising obviously involves carrying an adequate, well-assorted
stock. If every city acts alone, in endeavoring to market its bonds
direct, the city’s bond-selling activity will necessarily be sporadic.
Its ability to supply the investor will be limited by its own
necessities for money. The market will also be limited to the bonds
of the particular municipality. But if a state and its cities should
coöperate, there could be developed a continuous and broad market for
the sale of bonds “over-the-counter.” The joint selling agency of over
three hundred municipalities,--as in Massachusetts--would naturally
have a constant supply of assorted bonds and notes which could be had
in as small amounts as the investor might want to buy them. It would
be a simple matter to establish such a joint selling agency by which
municipalities, under proper regulation of, and aid from the state,
would coöperate.
And coöperation among the cities and with the state might serve in
another important respect. These 354 Massachusetts municipalities carry
in the aggregate large bank balances. Sometimes the balance carried by
a city represents unexpended revenues; sometimes unexpended proceeds
of loans. On these balances they usually receive from the banks 2 per
cent. interest. The balances of municipalities vary like those of
other depositors; one having idle funds, when another is in need. Why
should not all of these cities and towns coöperate, making, say, the
State their common banker, and supply each other with funds as farmers
and laborers coöperate through credit-unions? Then cities would get,
instead of 2 per cent. on their balances, all their money was worth.
The Commonwealth of Massachusetts holds now in its sinking and other
funds nearly $30,000,000 of Massachusetts municipal securities,
constituting nearly three-fourths of all securities held in these
funds. Its annual purchases aggregate nearly $4,000,000. Its purchases
direct from cities and towns have already exceeded $1,000,000 this
year. It would be but a simple extension of the state’s function to
coöperate, as indicated, in a joint, Municipal Bond Selling Agency and
Credit Union. It would be a distinct advance in the efficiency of state
and municipal financing; and what is even more important, a long step
toward the emancipation of the people from banker-control.
CORPORATE SELF-HELP
Strong corporations with established reputations, locally or
nationally, could emancipate themselves from the banker in a similar
manner. Public-service corporations in some of our leading cities could
easily establish “over-the-counter” home markets for their bonds; and
would be greatly aided in this by the supervision now being exercised
by some state commissions over the issue of securities by such
corporations. Such corporations would gain thereby not only in freedom
from banker-control and exactions, but in the winning of valuable local
support. The investor’s money would be followed by his sympathy. In
things economic, as well as in things political, wisdom and safety lie
in direct appeals to the people.
The Pennsylvania Railroad now relies largely upon its stockholders for
new capital. But a corporation with its long-continued success and
reputation for stability should have much wider financial support and
should eliminate the banker altogether. With the 2,700 stations on its
system, the Pennsylvania could, with a slight expense, create nearly
as many avenues through which money would be obtainable to meet its
growing needs.
BANKER PROTECTORS
It may be urged that reputations often outlive the conditions which
justify them, that outlived reputations are pitfalls to the investors;
and that the investment banker is needed to guard him from such
dangers. True; but when have the big bankers or their little satellites
protected the people from such pitfalls?
Was there ever a more be-bankered railroad than the New Haven? Was
there ever a more banker-led community of investors than New England?
Six years before the fall of that great system, the hidden dangers
were pointed out to these banker-experts. Proof was furnished of the
rotting timbers. The disaster-breeding policies were laid bare. The
bankers took no action. Repeatedly, thereafter, the bankers’ attention
was called to the steady deterioration of the structure. The New Haven
books disclose 11,481 stockholders who are residents of Massachusetts;
5,682 stockholders in Connecticut; 735 in Rhode Island; and 3,510 in
New York. Of the New Haven stockholders 10,474 were women. Of the New
Haven stockholders 10,222 were of such modest means that their holdings
were from one to ten shares only. The investors were sorely in need of
protection. The city directories disclose 146 banking houses in Boston,
26 in Providence, 33 in New Haven and Hartford, and 357 in New York
City. But who, connected with those New England and New York banking
houses, during the long years which preceded the recent investigation
of the Interstate Commerce Commission, raised either voice or pen
in protest against the continuous mismanagement of that great trust
property or warned the public of the impending disaster? Some of the
bankers sold their own stock holdings. Some bankers whispered to a
few favored customers advice to dispose of New Haven stock. But not
one banker joined those who sought to open the eyes of New England
to the impending disaster and to avert it by timely measures. New
England’s leading banking houses were ready to “coöperate” with the
New Haven management in taking generous commissions for marketing the
endless supply of new securities; but they did nothing to protect the
investors. Were these bankers blind? Or were they afraid to oppose the
will of J. P. Morgan & Co.?
Perhaps it is the banker who, most of all, needs the New Freedom.